Pay Yourself First Strategy
Implementing a "pay yourself first" strategy while maintaining a living margin requires a disciplined approach to financial management. Here's a step-by-step guide to allocating revenue to owner’s compensation, operating expenses, profit, and taxes.
Step-by-Step Guide
Determine Revenue Allocation Percentages:
Identify the percentages of your revenue that will go toward each key area:
Owner's Compensation
Operating Expenses
Profit/Tax Account
Example allocations might be:
Owner's Compensation: 20%
Operating Expenses: 50%
Profit/Tax Account: 30%
Set Up Separate Bank Accounts:
Income and Operating Account: All revenue is deposited here first and then used for day-to-day business expenses.
Owner’s Compensation Account: Allocated for the business owner’s salary (can be a separate account or paid from the Income & Operating Account based on a predetermined percentage or amount).
Profit/Tax Account: Set aside for profit, providing a financial cushion and reserved for tax liabilities.
Allocate Revenue Consistently:
Transfer funds regularly from the Income Account to the other accounts based on your predetermined percentages. This can be done bi-weekly or monthly.
Example Allocation
Let’s assume your monthly revenue is $50,000. Using the example percentages:
Owner’s Compensation (20%): $10,000
Operating Expenses (50%): $25,000
Profit/Tax Account (30%): $15,000
Steps:
Deposit Revenue:
All $50,000 is deposited into the Income Account.
Allocated to Owner’s Compensation:
$10,000 (20% of $50,000) paid to the Owner as Compensation.
Allocated to Operating Expenses:
$25,000 (50% of $50,000) allocated to the Operating Expenses.
Transfer to Profit/Tax Account:
Move $15,000 (30% of $50,000) to the Profit/Tax Account.
Monitoring and Adjusting
Regular Financial Reviews:
Conduct monthly reviews to compare actual expenses and income against your budget. Adjust the percentages if necessary based on changes in business performance or costs.
Expense Management:
Continuously analyze and manage your operating expenses to ensure they stay within the allocated budget. Look for ways to reduce costs without compromising quality.
Cash Flow Management:
Monitor income and outflows regularly to ensure positive cash flow. Use financial dashboards or software to monitor your financial status in real-time.
Benefits of This Approach
Ensures Owner Compensation:
By allocating funds to your compensation first, you ensure that the business owner is paid regularly, which is crucial for personal financial stability and motivation.
Maintains a Profit Buffer:
Allocating a percentage to profit helps build a financial cushion, providing a safety net for unexpected expenses or downturns, thus maintaining your living margin.
Prepares for Tax Liabilities:
Setting aside tax funds prevents last-minute scrambles for cash during tax season and avoids potential penalties or interest on unpaid taxes.
Promotes Financial Discipline:
This method enforces a disciplined approach to revenue management, ensuring that all key areas are adequately funded before any discretionary spending.
Example Scenario Over a Quarter
If your business continues to generate $50,000 monthly, here's how the allocations would look over a quarter (3 months):
Total Revenue: $150,000
Owner’s Compensation: $30,000
Operating Expenses: $75,000
Profit/Tax Account: $45,000
By following this disciplined approach, you ensure that your business remains financially healthy, with a clear strategy for owner compensation, profit, and tax obligations, thereby maintaining a solid living margin.